Can Its Private Pension Plan Offer Lessons to the U.S.?

By PETER PASSELL

Published: March 21, 1997

So apparently do most Chileans, who have enjoyed spectacular returns on their nest eggs since the country dumped the national pension system in 1981 for a savings plan that makes individuals responsible for financing their own retirement. And so do the Governments of Argentina, Mexico and Peru, which are all following Chile's lead, switching to private -- though heavily regulated -- pension accounts.

Indeed, what began as a model for born-again free marketers in stagnant Latin American economies is inspiring policy makers in the high churches of capitalism. Earlier this month, Prime Minister John Major announced plans to privatize Britain's pension system. And here in America, where many younger people doubt that Social Security will provide even a modest pension when they retire unless it is overhauled, a variety of similar proposals have been floated as the answer to low savings rates and high Social Security payroll taxes.

Over the years, ''the gains from privatization would be worth $10 trillion to $20 trillion,'' argues Martin S. Feldstein, an economist at Harvard who was the chairman of President Ronald Reagan's Council of Economic Advisers.

For all its apparent success in Chile, though, the question remains whether what works for a poor but rapidly developing economy would work in America and Europe -- which cannot hope to pay for the retirement of aging populations with the dividends from growth.

Advocates of privatization in rich countries do not see it as a miracle cure. But, like Mr. Feldstein, they do say it is a way to spur growth and a means of distancing the national pension system from the rough and tumble of entitlement politics.

For their part, skeptics focus on the drawbacks to privatization -- the relatively high costs of operation and its potential for unraveling support for a social safety net. They also caution that in the event investment returns go south in a privatized system, the government may still be on the hook -- a debacle that could shake an economy unprepared for it.

Given such concerns, the skeptics see no compelling case for leaping into the unknown. ''Chile couldn't fix the system they had,'' argues Peter Diamond, an economist at the Massachusetts Institute of Technology. ''Ours ain't broke.''

Chile's pension reform was driven by a mix of ideology and necessity. In 1973, after he brought down the elected Socialist Government in a bloody coup, Gen. Augusto Pinochet was left to cope with a moribund economy. He turned to a group of economists later known as the ''Chicago boys,'' American-trained Chileans who shared a commitment to the libertarian ideas of the University of Chicago's Milton Friedman. One of them, Jose Pinera (who earned his Ph.D. at Harvard), pushed tirelessly to change Chile's pay-as-you-go national pensions to a system of privately funded individual retirement accounts.

Mr. Pinera, then minister of labor and social security, was pushing on an open door. The existing hodge-podge of industry-based social insurance plans was unpopular, in no small part because it exacted payroll taxes in excess of 25 percent.

Today, workers deposit 13 percent of their wages in the retirement accounts. The accounts, which move from job to job with their owners, are managed by some 20 private mutual fund groups, known as Administradora de Fondos Pensiones, or simply A.F.P.'s.

To achieve what Mr. Pinera, who is now associated with the libertarian Cato Institute in Washington, calls ''radical reform with a conservative execution,'' the Government strictly limited the A.F.P.'s discretion to take investment risks. At the end of last month, the A.F.P.'s held 40 percent of their assets in Government-backed debt, 24 percent in interest-bearing bank deposits and 35 percent in Chilean stocks.

Buoyed by high interest rates and phenomenal gains on Chilean stocks, the A.F.P.'s have delivered a stunning 13 percent average annual return after inflation over the last 15 years. Equally important, Mr. Pinera argues, the switch to ''defined contribution'' accounts has ended the Government's discretion to raise pensions at the expense of future generations of taxpayers. But what intrigues observers most is the way the pension reform has meshed with Chile's goal of moving the economy to the fast growth track.

The economist's prescription for growth these days invariably includes prudent fiscal policies, high savings rates, tax reform and the development of liquid financial markets. Chile's pension makeover, Mr. Pinera argues, helped to accomplish each.

For starters, he notes, privatization made it impossible to paper over Government budget deficits with current cash flow from the pension system. The resulting fiscal austerity (combined with increased confidence that personal savings would not be taxed or inflated away) raised the savings rate from 16 percent in 1980 to an astonishing 28 percent. Mr. Pinera also argues that the substitution of mandatory pension savings for the 25 percent social security tax on wages sharply increased incentives to work.

Last but hardly least, the reform guaranteed a flow of savings to jump-start the small domestic capital market. The assets in A.F.P.'s now exceed $30 billion.